Economic problems of 1979 were buried, not resolved

Many voters opted for change in May 1979 because the UK’s economic condition seemed unsustainable. It could no longer export enough, or attract enough capital inflow, to pay for all the products it imported – including fossil fuels and food. The obstinate ‘current account deficit’ had forced Chancellor Denis Healey in 1976 to take an emergency loan from the International Monetary Fund (IMF), to stop a sliding Pound adding to already-high inflation. Then, as now, it was usually ‘Third World’ countries that had to turn to the IMF to stave off collapse.  The loan came with conditions that overturned the ‘Keynesian’ approach pursued by previous Labour administrations. Prime minister James Callaghan had to tell his party that higher public spending and lower taxes were worse than useless against the recession (see video below), and Healey had to adopt a covert ‘monetarist’ stance against inflation three years before his successor, Geoffrey Howe, openly embraced it.

The wide external deficit reflected a worsening gulf in labour productivity between the UK and its main industrial competitors. Output per employee in the early 1970s was over 50% higher in the US and almost 15% higher in West Germany . Unable to compete, Britain experienced unusually fast de-industrialisation, losing its manufacturing base while countries with better-equipped, better-educated workforces held onto their own.

Because its people were increasingly unemployed or suffering real income reduction, governments were hard-pressed to raise enough tax revenue for all their expenditure commitments. The budget deficits confronting the Conservatives in 1970-74 and Labour from 1974-79 started out as largely ‘cyclical’. Tax receipts fell, and social-security costs were pushed up, when economic growth had stalled after the collapse of the Bretton Woods monetary framework in 1971 and global oil price shock of 1973. But a large and growing element of the public deficit was ‘structural’ - destined to remain even when (or if) the economy started growing faster.  Governments had come under pressure to raise their spending faster than GDP, because they had taken responsibility for many things that voters wanted to spend more on – particularly healthcare, education, social housing,  transport and the environment. Tax receipts could, at best, grow no faster than GDP. In fact, they were set to grow less fast, because an income tax once confined to high earners had started to fall on ordinary working families, who leapt at Thatcher’s promised tax cuts.

Shrinking industry and restraints on pay led to rampant strike activity, which tempted governments (both Conservative and Labour) to blame over-strong trade unions for the country’s plight. Having entrusted the mission of ‘taming’ the unions to Labour in 1974, voters decisively turned to the more adversarial Conservative approach in 1979. Employees protested that their low productivity was caused by chronically low business investment, which left them working with insufficient and outdated equipment compared to continental counterparts. But the most prominent economists of the time blamed low private investment on governments spending too much of the national income (GDP), ‘crowding-out’ the private sector.

Stories from the strikes

Transcript

Public investment (as a proportion of GDP) reached a peak in 1975, as the government followed a ‘Keynesian’ strategy of boosting output and employment with extra infrastructure projects. But as private investment stayed down, critics claimed the state-led approach had left the country with “too few producers”. Their remedy was to shift resources from the ‘unproductive’ state sector back to ‘productive’ private industry, by privatising state-owned assets and scaling-down the welfare state.

The same diagnosis also encouraged a polar-opposite ‘alternative economic strategy’, which sought to make the state more active, promoting the technical innovation and industrial organisation of which private-sector management seemed serially incapable.  These opposing sides of the debate were evenly matched for a time, but voters moved decisively (with Thatcher) in the anti-state direction after 1979.

Under the carpet, not off the agenda

Seven elections and 36 years later, none of these ‘urgent’ and ‘critical’ problems has been solved. The UK is still running a wide and persistent current-account deficit, equivalent to 6% of GDP in the third quarter of 2014. Its fiscal deficit was, after much recessionary pain, brought down to zero under Thatcher’s Conservative government, but immediately jumped up again as that of her successor (John Major) fought a new recession. After Gordon Brown’s initial success, it bounced back to even higher levels after the crash of 2008.

UK labour productivity is still 20-30% below that of main EU counterparts, with a corresponding pay gap. Neither over-mighty unions nor an oversized public sector turned out to be primarily responsible for holding back efficiency, or the modernisation that might have promoted it.  Governments since 1979 have succeeded in taking an axe to public investment. Already falling in 1979, this has continued inexorably downward - as successive administrations have looked to the private sector to build new roads, schools, hospitals and other major projects, even though this needs large (and largely hidden) public subsidies to offset private firms’ higher borrowing costs.  But the promised bounceback of private-sector investment has not occurred, even with borrowing costs and corporate taxes cut to unprecedented low levels since 2010. In real terms, business investment stayed flat (as a share of GDP) until the mid 1980s, rose after Thatcher’s (1990) resignation only to fall back in the mid-1990s, peaked for the 2000 dot-com boom but then tailed downwards.

Changing the rules

How was the economy revived after 1979, by successive governments, if they didn’t solve any of these supposedly nation-breaking problems?  The political genius of Thatcher and her successors (on left and right) was to change the economic ‘rules of the game’ so that they could be managed or masked, and were no longer viewed as problematic.

The UK’s ‘external imbalance’ – the current-account deficit that had forced three previous Labour administrations into humiliating devaluations of the Pound – was about to be offset by the emergence of North Sea oil. Much of the lambasted mid-1970s public investment had gone into energy production which generated a widening export surplus through the 1980s, easily financing the non-oil trade deficit for which Callaghan’s government had had to turn to the IMF. By the time oil revenues started to dwindle in the 1990s, the government had dismantled the Bretton Woods ‘exchange controls’ so that the UK could finance its current account deficit with an equally surplus on its financial and capital account. The UK’s perennial attraction of foreign direct and portfolio investment is officially due to its much-improved business conditions and world-leading financial services sector – although an unrivalled network of loosely-regulated low tax channels undoubtedly helps.

The chronic fiscal imbalance – regular budget deficits and rising public debt – have also been made sustainable, as an easier option than bringing them down. After initially derailing the world economy and (along with the oil shock) triggering early-1970s ‘stagflation’, the collapse of Bretton Woods released the UK and other governments from the last vestiges of the Gold Standard. Governments which spend more than they raise in tax no longer have to persuade banks and households to lend them the money. They can simply print it, as the ‘quantitative easing’ since 2009 has made abundantly clear.

The ‘monetarist’ fear that excessive money-printing will cause high inflation (destroying economic growth) and currency depreciation (making foreign debts unaffordable) has not materialised. Although present policy is still predicated on (disputed) empirical evidence that economic growth slows when public debt reaches 90% of GDP, a rising minority of economists  now questions whether it has any clear upper limit. Governments just need to retain a sovereign currency not backed by precious metals – which the UK ensured under John  Major, with its opt-out from European monetary union.

Transcript

Persistent public deficits and rising public debt may, as Thatcher’s economic advisers warned, have adversely affected private investment. The solution was not to revive such investment, but to create conditions in which economic growth no longer depended on it. The economy staged an unprecedentedly long and steady expansion 1993-2007 despite stagnant or falling business investment, and the recent recovery has occurred while UK corporates are hoarding rather than spending their large piles of cash. Economists are still puzzling over how this was achieved, though the falling price of investment-goods (with digitalisation and foreign sourcing) is a likely contributor. Struck by private firms’ reluctance to invest, business leaders who once decried public investment are now beginning to mourn its passing, pointing to a legacy of underfunded and overstretched transport and energy systems, despite a brief upturn in state-financed projects around the Millennium.

Two post-1979 achievements  were undoubtedly essential, to ensure that the UK’s low labour productivity and low pay ceased to be an economic problem. The Thatcher governments removed the possibility of sustained employee protest, by restricting trade unions’ power and dismantling the industries in which they could organise most easily. And they removed the constraints on household borrowing, so that low pay no longer blocked the aspiration to buy houses, cars and other increasingly essential household goods. Household borrowing underpinned the 1993-2007 boom, and is essential to today’s recovery, with the ratio of household debt to income forecast by 2019/20 to be well above its seemingly unsustainable 2007 peak.

The reliance of today’s recovery on consumption, and of consumption on household borrowing, now concerns the Confederation of British Industry as well as for charities now grappling the social consequences of consumer debt. But it also helps to explain why the strikes and riots that peppered the 1970s have disappeared since the 1980s, despite the underlying economic imbalances persisting. Tax cuts allowed richer households to keep more of their money, while financial deregulation has enabled the rest to get by with less. Whereas voters once had to look to governments to borrow-and-spend their way out of recession, they are now allowed to do this for themselves.